Saturday, November 28, 2015

Hounded out of business II

Nathaniel Popper at the New York Times Dealbook, writes "Dream of New Kind of Credit Union Is Extinguished by Bureaucracy" It's a worthy addition to the series of anecdotes on how regulation, especially discretionary actions of regulators, are killing investment and businesses.

Again, we collect anecdotes as a challenge to measurement. There is no data series on numbers of businesses driven away by regulation. Yet.

This is a good anecdote, as it illustrates a too little reported underbelly of financial regulation.
Mr. Kahle saw how hard it was for the employees at his firm to obtain loans, and more broadly, how the existing financial system had helped contribute to the financial crisis. He thought he could do things differently, and he aimed to prove it when he began applying to open a credit union in early 2011.

Since then, the credit union has faced a barrage of regulatory audits and limitations on its operations, ...Now, Mr. Kahle is giving up on his dream of creating a new kind of bank, ...

...the troubles faced by his Internet Archive Federal Credit Union point to how difficult it can be to try out anything new in the heavily regulated industry.
After an 18-month application process, regulators let the Internet Archive Federal Credit Union open in 2012, but with restrictions that did not allow it to offer basic banking products, such as debit cards and online banking.
Mr. Modell said that during the 18-month application process, he and Mr. Kahle made 4,756 changes to their application and made it through only because of Mr. Kahle’s wealth.  “I could afford to say yes at every turn — every time they made some weird demand,” Mr. Kahle said. 
When they did get their charter from the N.C.U.A. in August 2012 — the first new credit union chartered that year — the Internet Archive Federal Credit Union was limited by the regulators to loans of $5,000 or less, and it could generally serve only people in a small area around New Brunswick, N.J., where the credit union was located.
It's a wonder that the US is still only in the mid 40s on the world bank's list of how hard it is to start a new business.  But just getting going, with restrictions that make profitability essentially impossible, is only the beginning.
it [the credit union] has faced a steady stream of official exams since: 11 in 14 months. In August, the credit union, by its own count, spent 187 hours dealing with regulators and only 61 hours dealing with customers.
The credit union’s other ideas for expansion were also shot down. In 2014, the Internet Archive Federal Credit Union tried to team up with an organization for migrant workers, the Farmworker Support Committee, to offer bank accounts and cheaper money transfers, but the idea was eventually rejected by an N.C.U.A. examiner.
And when the regulators turn against you, they know how to turn the screws:
Mr. Modell and Mr. Kahle said the red flags raised by the N.C.U.A. examiners had been over small discrepancies and record-keeping issues — and often turned out to be factually wrong.
“None of the compliance issues listed in the report were correct,” the credit union wrote in an appeal sent to the N.C.U.A. in May, after the agency lowered the credit union’s regulatory rating.
The N.C.U.A. sent its examiners on an increasingly frequent basis and requested more and more monthly reports from Mr. Modell... By mid-2014, the credit union had made less than $50,000 in loans and Mr. Kahle suggested to Mr. Modell that it was time to give up
And this business seems pretty much a poster child of benevolent capitalism:
“The original vision of this thing — of helping nonprofit workers, or helping the poor — they will not allow it,” Mr. Kahle said.
Given the bad press payday lenders get, this is doubly sad. The quantifiable result:
the number of credit unions in the United States has been shrinking each year since the crisis. There are around 6,300 credit unions, down from 7,000 in 2012 and 8,400 in 2007.
The larger backdrop would be amusing if it were not tragic. While the monetary policy part of the Fed has wanted stimulus and more lending, the regulatory apparatus has apparently been busy making sure banks don't lend, at least to anyone who needs the money, new banks don't start, and financial innovations don't emerge.

Update: LabMD CEO Michael J. Dougherty has a blog and a book.


  1. An anecdote does not make a case. But, your thesis is logical. We just went through the largest financial crisis in nearly a century. The most likely reaction would be to reign in a finance industry that brought down the world economy. The pendulum often swings too far. Over reaction is the price we often pay.

    I'm in the camp that thinks that the finance industry captured Congress and the result was that financial regulation was far too lax. The collateral damage of the Great Recession was just too great. In your previous post, you wrote of the pain of sovereign debt, do you not see the upheaval and pain associated with the Great Recession?

    I'd like to see some balance.

    1. I understand Gumpy's point. But, "hounded out of business" may be a stretch. Risk to NCUA deposit insurance is a large factor in chartering and insuring a new/de novo federally-insured credit union. One of the five (?) main factors which must be favorably resolved in a new credit union charter/insurance application would be "general character of management." I don't know what business the applicant was in, but, did he or any hire have requisite experience and character to manage an inception/ de novo, financial institution?

      I have experience in FDIC new bank/insurance applications and never saw anything like that.

      However, new banks are a big red flag. In the recent recession a disproportionately large number of de novo banks failed entailing inordinate losses for the FDIC fund. I don't know of any new bank insured from 2008 to 2014.

      Generally, a new FDIC member bank would require $7 million in capital and the approval order would require an 8% cap ratio for the first three years, and to achieve profitability in that time period. My understanding is that credit unions are mutual companies, not stock corporations, the organizers, I think, would contribute capital - which must be permanent, non-withdrawable. I don't know if NCUA has a minimum surplus requirement, but there are lending limits based on a percentage of surplus, say 20%, to one borrower; which may explain the $5,000 lending limit.

      In my experience, debit cards and internet banking are not basic banking services, although banks of all sizes offers such services which are provided by third parties.

  2. Why would a bureaucracy torture a business like that? My guess is someone in the banking industry felt this concept had to be killed in the cradle. I firmly believe that not only is cumbersome bureaucracy a problem per se, but that established private players can use it as a tool to stamp out newcomers.

    When we tried to open our physician-owned hospital 10 years ago we were initially denied a license based on a quibble about a sentence in a policy manual. We had to get our state reps involved to fight it. It was obvious that someone pulled some strings. You don't go through a multi-day inspection with flying colors and get nailed for a sentence in one policy manual.

    Then by some fantastic coincidence not one major insurer would give us a contract. We survived by being out of network and being in an area with a lot of PPOs. For years we actually made far more than if we had been in network. Then the insurers started giving us payment hassles, we sued, and as part of the settlement we signed a contract.

    I think the big box hospitals strong-armed the insurers into not contracting with us. They successfully killed another physician-owned hospital here the same way. Those owners sued and during discovery they found a "smoking gun" communication between one of the hospital systems and an insurer.

  3. On the other hand, I happen now to be writing about FINRA rule 2310, NASD Rule 2340. Yes, even more new rules that apply to brokerages, RIAs and others. The rules pertain to retail customer account statements. They concern unlisted REITs and DPPs.

    Bring out the bulverism, in spades, and to the hilt. The unlisted REIT and DPP industries are shot through with crooks. They have been retailed to the elderly for their steady distributions and "fixed values" (often obtained by lack of liquidity, and borrowing or eating capital to make distributions) and too many other horrors to cover in a comment.

    How bad is an unlisted REIT? A 10-year apartment REIT, sold at $10 a share in 2006, just sold out at $8.17 a share (Landmark Apartment) Multifamily is the hottest real estate market right, in the middle of a huge bull.

    Somehow, investors (many seniors) invested $10 a share in 2006, and come out with $8.17 after 10 years. In the hottest apartment market, maybe ever.

    Oh gee, what happened to all the money?

    I realize this comment is not persuasive, and I encourage anybody to read up on this. By the time you are through, you will be calling not for regulations, but the gallows.

  4. Do your blog and the article help? By this, I mean, doesn't it make it less likely that you will see small businesses start up in regulation-heavy sectors? This likely makes the collection of data somewhat delicate, because a regulator could claim that they haven't been harassing that many people of late, precisely because of previous harassment which kept people out in the first place. So what exactly entails good and proper measurement here?


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